Down payment help: What parents, kids should know before money is gifted
High real estate prices and new mortgage rules designed to clamp down on risky lending have made it harder than ever for first-time buyers to own a home.
Desperate to break into the housing market, cash-strapped millennials are accepting massive financial help from parents in the form of “gifted” down payments.
The latest stats from Mortgage Professionals Canada show down payment gifts from parents have doubled since 2000 — going from seven per cent in 2000 to fifteen per cent for homes purchased between 2015 and 2017.
The new Mortgage stress test — designed to predict whether homeowners could shoulder their debt if interest rates or their personal finance situation were to change — this means many first-time buyers who were previously approved for a high-ratio mortgage (which is when the down payment is less than 20 per cent) are completely out of the market now.Unfortunately, this legislation is trying to fix a problem that the Okanagan does not have; people defaulting and going into foreclosure as less than 0.0025% of the market. Most likely from poor financial management. However, the legislation will be in place by the 14th of January 2018, so its important to know.
To give you an example, my clients who were qualified for a purchase price of $450,000 and $410,000, now qualify for $380,000 and $340,000 with the same or even slightly higher down payment and the same income. That won’t get them much in Kelowna, where the average detached home cost $660,000
What parents should consider if they are thinking of gifting a down payment.
Some parents are refinance their homes to help their kids with down payments, which I think is very risky. Even though they may think their house is worth a certain amount of money, if the market “corrects,” the price of their own home may go down and they will be on the hook for the equity they took out of it. Equity that suddenly could be higher than the new market value.
The main thing people forget in real estate, is until you actually sell and cash out, you don’t have that money yet. So the value is just a number until it is cashed in.
If generous parents opt to sell stocks or mutual funds to help their kids come up with the money, they could face a hefty tax bill depending on the amount. If they borrow the money, they will be charged interest and need to have a plan to pay the loan, plus interest, back.
This only works if it is gifted. If the child starts to pay it back, it causes lots of issues as lenders frown on money being lent rather than gifted “because it increases the borrower’s debt-to-income ratio.
Another option is to sign as a guarantor on a child’s mortgage. There needs to be a lot of trust for the child if parents choose that route as their budget will directly affect yours and can lead to an inability to retire. Mortgage payments are only part of the cost of home ownership. Property taxes, utilities, insurance, condo fees, maintenance costs and emergency repairs all add up.
What first-time home buyers should know
The first rule of accepting a gifted down payment is that it has to come from an immediate relative. It’s also supposed to be a “genuine gift” that never has to be repaid, according to Canada Mortgage and Housing Corporation(CMHC).
The family member gifting the money may be required to sign a letter confirming that. The lender might also verify bank records to confirm the amount of funds being transferred to the buyer.
If you’re buying a property with your partner, you might want to consider protecting the money you receive from your family. Nobody buys property with their spouse and anticipates a split, but if that happens, your relative may not want your ex-spouse to walk away with half of that money.
Another thing to consider is that even with a gifted down payment, a lender will look at any prospective buyer’s complete financial picture. Good credit is always important. If the client has poor credit, no stability with income, and is getting the down payment 100 per cent as a gift, it would be hard for the lender to accept their mortgage application and may ask to have the parent on board as well. It is important to show that the client has the ability to save on their own, even if the down payment is being gifted.
An effective idea to save for a down payment is to maximize RRSP contributions and put the resulting tax refunds toward a down payment fund. Under the Home Buyers’ Plan, the government lets each first-time home buyer make a one-time $25,000 RRSP withdrawal that can be used for a down payment. If you plan to buy property with a partner who’s also a first time buyer, that’s $50,000 right there. You’ll have to repay the funds you took out of your RRSP within 15 years, starting two years from when the money was withdrawn.